Ready for the Bust in the Economy

Here’s a cartoon sent by one of our dear readers. We have readers all over the world. But Pamela must be one of the most remote. She lives on a tiny island in the middle of the Pacific. We’ve seen the photos. It looks stunningly beautiful. A South Pacific paradise.

Economic Cartoon

It’s a little surprising that someone who lives in such a paradise setting would trouble herself worrying reading The Daily Reckoning and worrying about macroeconomics. But the world of money is fascinating. And probably a lot more entertaining if you’re not in the middle of it.

Yesterday, investors must have felt like they’d rather be somewhere else. The Dow registered a loss of 268 points. Gold took a $49 beating.

We won’t know for sure until tomorrow. If tomorrow is another bad day – as it probably will be – then it will be clear that the last stage of the bear market has arrived. This should be the final drop…when stocks should go down to their ultimate bear market low.

Where will that be? We don’t know. Maybe Dow 5,000. Maybe lower. One way or another every major bull market needs a major bear market. The two go together like yin and yang, Abbott and Costello, or gin and tonic. Take one out of the picture and the other one no longer makes any sense.

We’ve had our bull market. It took the Dow from under 1,000 to over 14,000 in the space of 26 years. We’ve had a bubble too. The party was a lot of fun for everyone.

Now, it’s time to clean up. It’s time for the bust in the economy…and the bear market in stocks. That’s just the way it works. Sorry.

If this bear market is going to correct the entire bull market from 1982 onward, it has to take prices back to the levels they were when it began. Back then, you could buy the Dow (from memory) for about 5 times earnings. Now, (we’re not doing any research here…just broadly remembering the figures…) it’s at about 20 times earnings. If those numbers are correct, you’d expect the final low to come in about a quarter of where it is now…or about 2,500.

Another way to look at it is to ask ourselves what the Dow of ’82 would be today, adjusted for consumer price inflation. We don’t know the answer to that either…but we’ll guess that it would be about 4 times what it was then – or about 4,000.

So, now we have a range… We know roughly where this market could be headed – if it is the yang we’re expecting. And if that’s where it is going, a South Pacific island paradise would be a good place from which to watch it get there.